Forager's 7 best prospects and 6 complementary stocks for 2024

While large caps across the Australian and global markets have been on a hot streak, small and micro-caps have been left out in the cold. For instance, the ASX Small Ordinaries is essentially flat over the last year while the ASX 50 is up more than 8% in that same time period. The picture is healthier overseas with the S&P global small-caps index and large-cap counterpart up double digits. 

Perhaps most importantly, global large and mega-caps are trading on lofty valuations. In the US, small-caps are sitting at a 25% discount to the broader market. In Australia, large-caps have outperformed their smaller counterparts by 28% over the last three years. 

So is this the great diamond in the rough?

The Forager Funds Management team, led by CIO Steve Johnson, certainly think so. Two-thirds of the Forager International Shares Fund is invested in companies with a market capitalisation of under US$10 billion. 9 out of the Top 10 holdings in the Forager Australian Shares Fund have a market cap of under $1 billion. 

In this piece, I'll recap the big themes from 2023, their top 8 themes for the coming 2023/2024 financial year, and share 5 of their highest-conviction stocks heading into reporting season and beyond.

Highlights of the past year

For international fund Portfolio Managers Gareth Brown and Harvey Migotti, 2023 was a year for a rebound following the immense disappointment of 2022. It was also a second half dominated by a return to beaten-down growth names. Meta Platforms is up 200% since the fund doubled down on its position though it is taking profits incrementally.

And speaking of technology, the fund was invested in Twitter before Tesla CEO Elon Musk bought it out for the enormous sum of US$44 billion. M&A is always a good sign, essentially in small-caps because it helps prove a thesis that an investor would have had in the stock. But in the case of Twitter, it was just "weird". 

"Twitter was certainly one of the weirdest takeovers we have ever been a part of. It was a very welcome 'get out of jail free' card on an investment that we really had no right to make a profit on," Brown quipped.

For Australian fund managers Alex Shevelev, Gaston Amoros, and Johnson, it was a year for sticking to your guns. 

"The major positive contributors dominated 2023. We had one poor performer that cost the fund more than 1% of performance and 10 that contributed more than 1%," Shevelev noted. The one poor performer, incidentally, was Whispir (ASX: WSP). 

Despite the economic data suggesting otherwise, consumers continued to splurge their cash on holidays and travel. The fund's investment in Tourism Holdings (ASX: THL) ended up being the top contributor over the past year. Meanwhile, turnaround software play Gentrack (ASX: GTK) made the second-largest return for the fund.

7 big themes ('best prospects') for 2024

Each of the presenting fund managers made their case for key themes to watch out for over the next year. One theme is present across both funds - the unloved and underpriced opportunity in small and micro-caps. 

At the global level, Brown and Migotti are watching these key themes:

• The US housing rebound, which remains an important bet for the fund. Two US building stocks are outlined below as high-conviction calls for the next year.

• Is the UK's pessimism justified? The Forager International Shares Fund has investments in a range of "cheap stock prices" despite a difficult economic environment.

• Quality compounders, which will always be a key part of the portfolio

In Australia, the team are watching three specific sectors:

• Technology, where one-third of the fund is invested in

• Healthcare demand, where 10% of the fund is invested. The argument is that these returns will be uncorrelated to economic shocks.

• Doubling down on tourism and consumer discretionary thematics. Although Tourism Holdings was the fund's largest individual contributor last year, the fund also holds a small position in Qantas (ASX: QAN)

... and 6 stocks to complement these themes

In the international fund, two names stand out and both are market leaders in different parts of the broader US housing story. Both companies have had compound annual growth rates (CAGRs) of at least 10% over the last 10 years and both are exposed to a part of the housing story which is not as vulnerable to the ups and downs of the homebuilding cycle.

Fortune Brands has underperformed over the last decade but Migotti argues that fortunes (pardon the pun) are changing after it spun off its underperforming cabinets business in the last six months. 

"It has been masking the rest of the portfolio," Migotti said. 

Ferguson is a re-listing story which moved from its homeland in the UK to the US. 95% of its revenues now come from the US and it also may have a huge tailwind coming over the next 6-12 months: inclusion in the S&P 500. A stock's inclusion into a benchmark index is a big plus for getting noticed.

"It also forces people that cover this sector to look at this beautiful company that we think has done a tremendous job over many years," Migotti said.

Finally, Brown points to a high-conviction name which they are hoping will open new doors for fund returns - literally. Janus International is the market leader in the niche automatic doors and security systems business. With operating margins of over 20% and a multi-year low in its valuations, he believes this stock is due for a run.

"It's been a very overlooked smaller business," Brown said before adding "the self-storage industry can have some pretty brutal cycles so we are careful about our exposure to the industry and this business."

Back home in Australia, Johnson remains a fervent believer in the fund's largest holding. RPMGlobal (ASX: RUL) is a mining software business and could start to make good on profit generation after years of building revenue and a sticky customer base. A $35 million buyback always helps with sentiment as well. 

Shevelev also highlights ReadyTech Holdings (ASX: RDY) for its sticky customer base and recurring revenues. The software company uses a subscription-style model which it then leverages through customer wins and price increases. 

"We think this will continue for the long-term and we think the higher capital expenditures will reduce as a percentage of revenue over the next couple of years" he added.

Finally, in the healthcare space, Amoros highlights Integral Diagnostics (ASX: IDX) which the fund views as a potential M&A play. The radiology business has grown revenues consistently for more than 20 years but was impacted during the pandemic as a demand slowdown and higher costs crimped margins. But all that could change soon.

"Our view here is that volumes will normalise and margins will reset gradually," he said.

This wire is a summary of Forager's 2023 Investor Roadshow and first published for Livewire Markets on Monday, 31 July 2023. You can watch the full presentation here.

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